Efficiency Implications of Trading in a Bifurcated Market

Abstract

This study used detailed transaction data to analyze both the frequency of trading and the causes of price dispersion for short-term water leases in the Edwards Aquifer in Texas. The finding that trading activity closely follows episodic droughts confirms the efficiency-enhancing property of water markets. In this relatively homogeneous market, price dispersion poses a conundrum. The intertemporal price variation attributable to droughts indicates considerable price elasticity of demand indicative of potentially large welfare gains from trading. Even after controlling for mandated cutbacks in pumping, considerable price dispersion can be attributed to the type of transaction, such as between irrigation and non-irrigation users. Interestingly, transactions between non-irrigation users occur at 2.7 times the price as between irrigation users. This difference can be attributed to regulatory restrictions on water uses.

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